June 12, 2009

The credit-card companies have stolen his customers by taking a softer approach to charging outrageous interest rates. During the subprime lending boom, mortgage banks shouldered into shark territory, too.

Loan sharks are called mobsters. Thieving legitimate lenders are called capitalists -- free to impose any terms short of kneecapping on their troubled borrowers. Washington treated capitalist sharks as role models and beloved campaign contributors -- that is, until the economy collapsed and debtors (aka voters) emitted a collective scream.

Now, maybe, borrowers might catch a break. There is serious talk in Congress and the White House about creating a Financial Products Safety Commission, charged with protecting consumers and the country from the depredations of irresponsible lending.

Creators of financial products have been running ahead of the hangman for many years. Every other market has had to accept consumer-safety rules, mandated by the Consumer Product Safety Commission or some other government body. Laws regulate the ingredients that go into cosmetics, the buckles on children's car seats, the freshness of meat shipped to supermarkets and the safety of prescription drugs. You can’t buy firecrackers in many states. If car tires explode, they can be recalled.

Exploding mortgages

Yet no law required the recall of the exploding mortgages that drove tens of thousands of borrowers into foreclosure and bankruptcy. No one recalled the dangerous subprime credit cards that arrived in the mail already loaded with high-rate debt from application fees. The consumer-credit industry can dream up any sneaky product it wants and no one polices it for harm. As it turned out, the harm went viral.

“This financial crisis started one mortgage at a time, one household at a time, and it destabilized the world economy,” says Elizabeth Warren, a Harvard University law professor. She is chairman of the Congressional Oversight Panel, which aims to bring accountability to the hundreds of billions of dollars flowing through the governmentís Troubled Asset Relief Program.

Warren proposed a Financial Product Safety Commission two years ago in an influential article written for “Democracy: A Journal of Ideas,” a progressive publication. Recently, her idea was endorsed by the White House and introduced as legislation in the Senate and the House of Representatives.

Industry opposition

The powerful financial industry will oppose it at every turn, but Warren isn't discouraged. “They said we’d never get food labeling because of the influence of the food lobby,” she says. “But now you can walk into any supermarket and see how much sugar is in each type of cereal.”

Today, almost every borrower has an enraging credit-card or mortgage story -- if not their own, then a story from a child or friend. The political moment for ending legalized loan sharking may finally have arrived.

The commissioners would have two principal jobs. One is true disclosure. They would require simple, standardized price and interest-rate disclosures so you could compare the cost of one credit product with another. If a pricing mechanism was too complex to explain simply, and trapped consumers into paying more than they expected, it would be banned.

Fine-print billing

A good example of complexity is double-cycle billing on credit cards. Under this system, you were charged interest on debt that you had already paid off in the previous month. You didnít owe the money anymore but were charged interest anyway. Double-cycle billing was disclosed in the fine print but few consumers understood it. Once they did, public anger -- plus, finally, Congressional action -- put a stop to it.

The commission would also have the right to ban practices considered unsafe. One example: the mortgage prepayment penalties that prevented homeowners from getting out of subprime loans when interest rates went shooting up. Prepayment penalties are a way of charging more for loans than borrowers expect. If lenders need those fees to make the loan profitable, they should charge them upfront, where consumers can evaluate them.

The federal government could have stopped at least some of these abusive practices. Under the 1994 Home Ownership and Equity Protection Act, the Federal Reserve had the power to end unconscionable mortgage lending, including loans made without regard to whether borrowers could repay. Under the Truth in Lending Act, the Fed also has the authority to address credit-card abuse. It didnít bother until the roof came crashing down.

Consumer's friend

The Fed will fight to hang on to its authority over mortgages and credit cards. But it has forgone any right to be trusted as the consumer's friend. So have the banking agencies, which could have helped with credit cards, and the toothless Federal Trade Commission.

Last month, President Barack Obama signed the Credit Card Accountability Responsibility and Disclosure Act, which will end some (not all) of the abuses in the credit-card business. But legislative action always comes long after the damage has been done. And it canít anticipate what sharkish product the financial industry will dream up next.

That's another reason for setting up an independent Financial Product Safety Commission. It would be on the job all the time, requiring cost disclosure and monitoring risks.

What passes today for consumer protection not only failed consumers, it failed the country. Time for a new approach.

Bryant Quinn, a leading personal finance writer and author of “Smart and Simple Financial Strategies for Busy People,” is a Bloomberg News columnist. She is a director of Bloomberg LP, parent of Bloomberg News.